My name is Mark Goodfield. Welcome to The Blunt Bean Counter ™, a blog that shares my thoughts on income taxes, finance and the psychology of money. I am a Chartered Professional Accountant and a partner with a National Accounting Firm in Toronto. This blog is meant for everyone, but in particular for high net worth individuals and owners of private corporations. The views and opinions expressed in this blog are written solely in my personal capacity and cannot be attributed to the accounting firm with which I am affiliated. My posts are blunt, opinionated and even have a twist of humor/sarcasm. You've been warned. Please note the blog posts are time sensitive and subject to changes in legislation or law.

Monday, October 1, 2012

Holy Hotchpot—Equalizing Uneven Advances to Children in your Will

Many parents stress unnecessarily, over how thy will equalize their wills, where they have made unequal gifts to their children during their lifetime. Don't fret; today I will discuss a simple "hotchpot clause" that can alleviate your concerns.

Families with the financial wherewithal often advance funds to their “financially dependent” children to fund their living expenses or help with the purchase of a house, to the exclusion of their financially "independent children". In many cases, parents assisting financially dependent children, have the expectation that when they pass away, the funds they have advanced during their lifetime to financially dependent children will be considered advanced on account of those children’s inheritances, not separate gifts above and beyond their inheritances.

I have clearly stated in two of my most read blogs, “Is it Morbid or Realistic to Plan for an Inheritance?” and “A Family Vacation – A Memory worth not Dying for" that where parents have the financial means, it is my opinion that they should consider making partial advances on account of an inheritance while alive. Some readers have stated that they do not agree with my views. However, for today, let’s suspend the debate on whether parents should or should not provide partial advances to their children and assume a situation where a parent has made unequal advances to their children during their lifetime and they want to equalize these advances in their will.

Over the years, a legal concept now commonly known as a “hotchpot clause” has evolved to deal with the equalization of the beneficiaries of an estate, where one or more of the beneficiaries have already received money during their parent’s lifetime. When a hotchpot clause is inserted in a will, the clause will prevent a beneficiary (typically a son or daughter) from “double dipping” where the parent intended any money advanced during their lifetime to be considered a pre-payment of an inheritance, rather than an advance over and above an intended inheritance.

This concept is best illustrated by an example.

Richie and Betty Rich have three children; RJ, Archie and Veronica. Richie and Betty have an estate of $1,000,000. Their son RJ runs a successful comic book store and makes a good living, but is by no means wealthy. Archie, the youngest, suffers from an entitlement issue and has never finished school nor held a full-time job. However, he has always been the apple of Betty’s eye and can do no wrong in his mothers' eyes. Veronica gave up a promising blogging career when she married, but unfortunately her marriage fell apart and her husband left her with two young children.

Over the past few years, Betty has advanced Archie over $100,000 to fund his snowboarding lifestyle. Furthermore, Richie and Betty both have felt the need to advance $200,000 to Veronica to fund the private school education of her children.

It is Richie and Betty’s intention to have their $1,000,000 estate split equally when they pass away, however, they want the funds previously advanced to Archie and Veronica to be accounted for, such that RJ gets 1/3 of their estate, including amounts previously advanced to Archie and Veronica.

If Richie and Betty were to die in a car accident today, their current will stipulates that their estate is to split equally amongst RJ, Archie and Veronica, such that each child would be entitled to $333,333 each ($1,000,000/3), which is not the intention of Richie and Betty.

However, if Richie and Betty had met with their lawyer before they died in the car accident, their lawyer could have inserted a hotchpot clause, such that their estate would be considered to have been $1,300,000 ($1,000,000 plus $100,000 advanced to Archie and $200,000 advanced to Veronica). Thus, when the estate was settled, RJ would receive $433,333 ($1,300,000/3), Archie would receive $333,333 ($433,333-$100,000) and Veronica would receive $233,333 ($433,333-$200,000).

To view an example of what a hotchpot clause may look like, please follow this link. A word of caution; you should always engage a lawyer to draft the clause, as a hotchpot clause must mesh with the rest of your will.

“From the basis of equitable treatment between beneficiaries, a hotchpot clause is a useful tool” comments Albert Luk, a lawyer at Devry Smith Frank LLP and past contributor to my blog. “However, one must always be aware that a hotchpot clause requires evidence of provable advances to the beneficiaries. Bad (or no) book-keeping may render a hotchpot clause ineffective. The key is to keep good records.”

There is obviously no requirement for parents to be equal and fair to their beneficiaries. However, where parents intend to split their estate equally amongst their children/beneficiaries and yet, have made loans, advanced funds for house down payments or just advanced funds to their children in unequal amounts while alive, their estate planning must include the consideration of those gifts and loans (with proper evidence as noted by Albert Luk above) and they should ensure their lawyer has drafted a hotchpot clause.

Bloggers Note: If you are interested in delving deeper into this topic, Corina Weigl of Fasken Martineau DuMoulin LLP wrote a great paper on this topic in 2001.

The blogs posted on The Blunt Bean Counter provide
information of a general nature. These posts should not be considered specific advice;
as each reader's personal financial situation is unique and fact specific.
Please contact a professional advisor prior to implementing or acting upon any
of the information contained in one of the blogs.

Useful stuff to know ... but about the weird name "hotchpot" Wikipedia http://en.wikipedia.org/wiki/Hotchpot - why not call it "child equalization" or the "pie sharing clause" i.e. something more descriptive?

Although derived from a french word, the common use is from English law. So what do you expect from a country that gave us knackered, the loo and Bees knees :). One of my golfing buddies provides me with a new British/English slang word every golf round, although most cannot be repeated and most follow a missed 4 ft. putt.

4ft?!! that's long range. I missed a 2 footer the other day with strong wind blowing across a steeply sloped fast green. From uphill as the ball trickled by the hole it kept going going going going and stopped 15 yards away off the green. From a nice par to an 8 from 2 ft! Now that's worthy of "boll_ _ ks" though in Scotland they might say "sh_te"!

"“However, one must always be aware that a hotchpot clause requires evidence of provable advances to the beneficiaries. Bad (or no) book-keeping may render a hotchpot clause ineffective. The key is to keep good records.”"

This is an interesting perspective on wills and estate planning that I rarely see directly addressed. I agree that it is wise to look at the estate in the context of one's full financial life.

I do have a question about the "keep good records" comment. In your experience, what does that look like? Is it simply records left at the family accountant/lawyer? Or does it involve something more formal in the will (e.g. "Veronica would receive $233,333 ($433,333-$200,000), the $200,000 deduction as per Schedule 2" (schedule 2 could then provide dates and amounts of the payments already made)

Hi Bruce- I have emailed Albert Luk to get his legal take on this. What I have seen in the past is the parent just photocopy the cheque and have the child sign an acknowledgement they received the money. I think the idea of the hotchpot clause is to not put specific amounts in the will, since they could constantly change, but that the parent keeps the records (provide a copy to accountant or lawyer)and the hotchpot clause takes into account whatever monies have been advanced at the time of their passing.

Bruce- this is Albert Luk. Thank you for the question. The quick and dirty answer is that you would NOT attach advances to beneficiaries in the will. A probated will are public records. Accordingly, for privacy reasons, most people do not want to make their family affairs public. As Mark indicated, record-keeping for this purpose would consist of things like photocopies of cheques, bank statements, receipts, promissory notes etc. There is no "official" form to follow. The emphasis is on whether the executor has sufficient records to administer the estate properly. You can email me directly at albert.luk@devrylaw.ca if you have any questions. Thanks.

I can see the practical advantage to maintaining those records outside of the will itself. Given that gifts and funds might be distributed over many years, keeping track could prove difficult. It's good food for thought when it comes to designing a will - broader financial and personal considerations need to be taken into account.